How to Spend Your Next Tax Return (Part 2)

The idea of investing in your IRA is very obvious: you are investing in yourself and your future. Early tax return time i.e. February through March also happens to be a very good time to invest. Just after the holiday stock optimism, a cloud of the unknown sets in on Wall Street which generally drives stocks down at this period of the year. This is a good time to buy but you must do so early. Wall Street generally starts feeling the impact of IRA money pouring in from late tax returns in late March which spurs the market before the general May downtown.

Roth IRA remains by favorite investment vehicle especially if they are filled with ETFs (five at the maximum) and below are five classes of investment vehicles and examples of what you should purchase with your next tax returns probably in equal twenty percent measures:

International Fund: A sizeable portion of your portfolio should be devoted to international exposure. You will miss out on explosive international growth if all your investments are directed internally to the Americas- emerging and developed markets can form part of your strategy. CRIB i.e. China, Russia, India and Brazil comes to mind. Understanding the risks is also important in the choice of global investments- for example investment in China and Russia is an investment in commodity growth, while India and Brazil is more service oriented. Currently I love Honk Kong ETFs or may be Australia. These are well positional developed markets with the transparency advantage which have stocks that can take advantage of their proximity to the red hot China and Indian markets. I love EWH (which I own and which contains Honk Kong traded stocks with good exposure to the mainland) and EWA (its Australian Equivalent).

Core Growth Fund: It is necessary to have a core growth portion of your portfolio around which the rest of your portfolio is built. This should be a representative cut of the total market probably an index tracker, like the Russell 1000 or S&P Growth index. This portion of your portfolio will be a steady hand in the storm and should over time constitute a bulwark of your explosive portfolio. An investment in growth and capital gains is an attractive option for younger people. Older folks can substitute this class for a core value play. Currently I like IWF, IWZ (which I own) and RPG.

Small Cap: The worst kept secret on Wall Street is that over time, small cap stocks outperform all other classes of stocks. It is pretty obvious that this will be the case if Wall Street keeps being a growth chase addict; small caps stock have the most headroom for leveraged growth which can come by huge capital gains, market share gains and indeed a buy out by a bigger, threatened competitor. This could me cash machine for owners and without the headache of having to rebalance your portfolio an ETF is the easier way to invest in small caps. Current PWY, RZV and PZI look very interesting to me. By the time you read this, I should own at least one of the three.

Sector of the Future: After playing regional, style and capitalization classes, and the next best hunt is sector classes. In here, you will need to do some homework or rather make a good guess of what the future holds. It simply involves choosing a sector you perceive holds the most promise for the future. To some it might be biotechnology (look into PBE, XBI) which considering the ageing population will be a combo way to play growth, technology and healthcare. To others it might be nanotechnology (look into PXN) and to others it might be alternative energy (PBW is one of the best out there now). Depending on which way to go, it might be necessary to time your entry into this ETF to coincide with a downturn or slowdown in such sectors since you are essentially looking to secure long term gains not ride the current momentum.

Stock of the Future: This is my only non-ETF play in a model IRA portfolio. This is a common stock of a company you have a hunch about. This might be a stock on a rally, one that is beaten down and essentially is in the hand of a guru. This is the next BERKSHIRE HATHAWAY INC and you are basically seeing if the company is in the hands of the next Warren Buffet or Jack Welch of GE. Imagine if you had bought one BRK.A stock at $200 in the early eighties, you did be sitting on $80, 000 plus today. That is humongous! Of all the five classes, this will require more homework than any other. You will not only need to effectively know the company by poring through annual reports and filings as well as website and may be even cold calling their offices, it might require to have an insight into the strategy, managerial style and personality of the man on top. Essentially this is a focused long term value investment in one man, his brain, and his health. Shun companies with old men beckoning on retirement, those that like to spend extravagantly and companies with shaky financials. Cash is king when selecting this stock, because a major weight to your bet is that this company will essentially become a conglomerate if it is not one already which will mean acquiring its way into new businesses. Currently, Sears Holding (SHLD) under Eddie Lampert has every smell of it- yes, I own SHLD and I am not ashamed to say it. Get yours.

To conclude, before investing it is necessary to understand the risks in each of the investment classes, market trend, and your own risk tolerance and how this investment allocation strategy will fit your retirement age target. For example I will personally reduce investment in international funds and substitute the ETF in the sector of the future for income generation fund like a Real estate Investment Trust portfolio if I am five years to retirement. This will also impact my stock of the future, because at ten years to retirement let us be real you don’t have that much of a future ahead- okay, just joking.

How to Spend Your Next Tax Return (Part 1)

Tax return time is nigh; by year end through the end of first quarter 2007, Americans or dwellers of this hood would be seeking out money back guarantees from Uncle Sam. This yearly ritual is a kill time for retailers and credit card companies. Consumers for the most part spend their tax returns to get that Patio they badly wanted, or that flat screen TV they couldn’t afford at Christmas but bought anyway on their high interest credit card which they pay back. But this strategy is hardly the best way to spend a hard earned return, which is basically zero interest money you gave to Uncle Sam for one year. The average tax return has risen by about $200 to $2500 annually in the last couple of years. This means a lot of cash in the hand of consumers that is either spent before it was gotten or is not planned for.

The danger of anticipatory spending or unbudgeted spending is usually the guilt that sets in the second quarter after a tax return is badly spent with the promise to do better next year. To scale this guilt trip, a simple rule of the thumb need be applied to tax returns. This has to do with what you should do and not do with tax returns. Indeed, if tax returns are a bad deal from government (since it is a sub inflation rate loan you gave to Uncle Sam), then it behooves on you to ensure you put the money somewhere it would yield a minimum of inflation plus some in the next coming year and ensue the one year capital gain loss is made up for rather quickly. The good thing of course is that there is no lack of good investment vehicles to put your money into, but first the rule of the thumb.

To get into the nitty-gritty of tax returns, we must first trace the source (more on tax credits read hyperlink). Fifty percent or more of annual tax returns is a direct result either education related credits (education spending/deductibles, Hope Credits, education loan interest deductibles) or real estate tax credits (mortgage interest credits, real estate investment credits). What this means simply is that tax benefits from primary home ownership and being in school constitutes a sizeable chunk of tax returns. This leads us to the rule of the thumb for spending tax returns christened “Cash in Hand Rule” by yours sincerely. It simply states that after 10% discretionary spending (which you can use to spoil yourself and your loved ones); half of your tax returns should be put into paying off the principal amount of your mortgage loan and another half into your retirement account preferably your IRA. Of course what you do with your money is still entirely your business; but be wise.

The reasons for this rule are obvious: paying down your principal mortgage amount will reduce your loan repayment term (see mortgage calculator to find out by how long). This in turn will reduce your long term loan interest amount which is the real cost of your mortgage and indeed your home. Hence, using the money you gave interest free to Uncle Sam, you buy down the interest rate of your home by reducing your principal. Indeed, in one fell swoop you have nearly recovered the lost annual investment in Bank Du Washington DC. The idea of investing in your IRA is very obvious: you are investing in yourself and your future; more on what to invest in, in the next contribution on this page.